CLIMATE FINANCE 101: WHAT ARE GREEN BONDS
AND HOW CAN THEY FIGHT THE CLIMATE CRISIS?

Green bonds work like regular bonds. But they specifically are meant to finance projects with positiveenvironmental impacts.
By Georgie Wilson, Science and Solutions Intern

The climate crisis is a fast-growing problem for our world, and one of the key issues
we face today is finding the money to finance solutions. At the most recent UNFCCC
Conference of Parties (COP 28), climate finance was a crucial point of discussion.
One of the most publicized climate finance developments out of COP 28 wasthe establishment of a Loss and Damage Fund to address the unavoidable impactsof climate change felt in developing countries.
Along with the Loss and Damage Fund, international leaders recognized theimportance of providing long-term financial stability in facing the climate crisis.
This focus spilled over to initiatives outside of, but complimentary to, the COP. One ofthese efforts was the creation of the Joint Declaration and Task Force on Credit
Enhancement for Sustainability-Linked Sovereign Financing for Nature and Climate.
What does this mean for climate finance? In essence, it works to support long-term
financing solutions for emerging countries instead of short-term debt assistance thatsolely relies on international development support.
1This is where we find green bonds at the heart of debt financing opportunities to faceclimate change.

WHAT ARE GREEN BONDS?
“Green bonds are financial instruments that finance green projects and provide
investors with regular or fixed income payments,” according to the World Bank.
They serve as a type of capital-raising mechanism that a variety of financial institutions– including the International Finance Corporation (IFC), the World Bank’s private
sector arm - and sovereign nations use for debt financing.
These green bonds work like regular bonds, as they are typically linked to an
asset and backed by a bank’s balance sheet. However, they specifically are meant tofinance projects with positive environmental impacts.
While green bonds are often seen as identical to climate bonds, green bonds offera broader spectrum of instruments related to environmental projects. Climate
bonds on the other hand, specifically are bonds that finance projects to reduce carbon
emissions or adapt to climate change impacts.
The first green bond transaction occurred in 2007 following a report fromthe Intergovernmental Panel on Climate Change (IPCC) showing global warmingand human activity linkages. This data inspired a collective of Swedish pension
funds to work to invest in “green” or climate-focused projects that same year.
The research done by the pension funds’ bank led them to the World Bank and soonafter, success came in 2008 when the World Bank issued the first official “greenbond,” which served as a benchmark for the green bond market as it set defined
criteria for green bond projects and included impact reporting as a key standard.
Since 2008, the green bond market has taken off and been growing as a financing
option throughout the world. The Climate Bonds Initiative launched the Climate Bond
Standard in 2010 as a transparency standard for the green bond market, with the first
corporate and municipal green bonds being issued soon after in 2013.
As green bond issuance gained volume, the Green Bond Principles (GBP) were
established in 2014 by the International Capital Market Association to ensure
credibility for green bond issuers by promoting transparency guidelines for the use ofgreen bond proceeds. While it is not mandatory to abide by the GBP, many issuers
adhere to these guidelines in order to certify the green bonds are viable.
2Despite the growth of green bonds in the past 10 years, geopolitical events like theCOVID-19 pandemic, Russia's war in Ukraine, and rampant inflation shockedinternational capital markets. Global bond issuance took a hit, with the first-everfall to $877 billion USD in general green, social, sustainability, and sustainabilitylinked (GSSS) bonds in 2022.
However, annual issuance of impact bonds rebounded to $939 billion in 2023,
with green bond sales from corporations and governments growing to its highest
annual issuance volume of $575 billion.

HOW DO THESE TRANSACTIONS WORK?
“Issuers often develop a green bond ‘framework’ in support of their environmental andsustainability objectives and then apply this framework to issue multiple bonds,” theDepartment of Energy says.
The projects eligible for green bonds will most often be described in a pre-issuancereport that details its alignment with the Green Bond Principals, has science-based
goals, and is certified with a standard similar to the Climate Bond Standard.
As the green bond is a longer-term debt instrument, this means that the issuer, orcreator, of the bond must have a strong balance sheet and a high credit rating. In orderto ensure high ratings with strong financial backing, green bond issuers are usuallywell-established and publicly traded corporations or municipalities.
Once the green bonds are sold to raise the capital for environmental projects, issuers
are responsible for managing the use of proceeds to adhere to the objectives of thegreen bond. Whether the issuers directly fund projects or pay for service agreements
to have another entity run the project, issuers will usually release public post-issuancereports to account for the use of funds.
Within green bonds, there are a variety of different intricacies concerning the types ofproceeds and the party who is responsible for the debt; however, the basic structure
and requirements for these green bonds remain consistent.

THE PROS AND THE CONS“GSSS markets are central to international progress on climate change because they
are the most effective mechanism for ensuring private capital is allocated todeveloping economies,” the International Finance Corporation says.
3For emerging market economies, green bonds offer a form of sustainablefinance from a variety of multilateral institutions that earlier would have been deemed
too risky for private investors.
However, green bonds are still a relatively new idea in the financial world, and a large
risk that comes with this new form of green finance is greenwashing. Despite theGreen Bond Principals and Climate Bond Standard, there are no universal
requirements or universally recognized standards for determining how
environmentally-friendly a bond is. There is also a risk that governments or companies
may not conduct the proper due diligence on the projects backing these green
bonds, and this responsibility may even fall on the investors.
Banks and other green bond issuers have worked to mitigate greenwashing throughannual impact reports, as seen from multilateral institutions like the International
Finance Corporation. However, identifying the “greenness” of a green bond is not a
perfect process, and so green bond issuers usually rely on external rating
agencies as well as the Green Bond Principals to ensure the bonds truly support
sustainable projects.
Despite the risks that come with green bonds, this finance mechanism will continue tobecome more effective as it becomes normalized in international capital markets.
Since the United Nations-sponsored “Principles for Responsible Investment” in
2006, over 5,000 financial institutions have signed onto these guidelines.
“Green bonds raise awareness for the challenges of climate change and demonstrate
the potential for institutional investors to support climate-smart investments throughliquid instruments without giving up financial returns,” says the World Bank.
Whether it be for a wind farm, biodiversity conservation, or energy efficient public
transit systems, green bonds have potential to grow further as a pivotal financing
mechanism for emerging markets in the fight against climate change.

WHAT HAPPENS NEXT?
As we continue working on climate solutions in 2024, the green bond market is a key
piece of the puzzle that must be demystified.
With more green bonds being issued every year, emerging economies are being
exposed to additional financing opportunities that may have the potential to position
them as leaders in the climate space!
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